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Board of Governors of the Federal Reserve System Vice Chair for Supervision Randal Quarles described innovation in the U.S. payment system and highlighted the risks presented by digital currencies.

In remarks at the 2017 Financial Stability and Fintech Conference, Mr. Quarles asserted the need to find a balance between innovation and stability in the payment system. He explained that while innovation in this area has traditionally been inhibited by high barriers to entry, those obstacles get removed as more users adopt new technologies. At the same time, Mr. Quarles said, the reduction of technological barriers may result in the introduction of additional risk.

As an example of this additional risk, Mr. Quarles discussed the dangers inherent in the use of digital currencies. He described how the main payment networks use centralized technology to process and safeguard the public’s electronic fund transfers. Regulated banking institutions provide deposit money to the public and are a main source of trust for these systems. Digital currencies, however, are not backed by secure assets and do not carry the same level of trust. The widespread use of currency that “cannot be predictably redeemed for the U.S. dollar in times of adversity” may have serious implications for liquidity, price risk and credit risk, he said. If a digital currency becomes the center of a large-scale payment system, he cautioned, it would be unclear how the system would be able to respond to economic stress.

Mr. Quarles also urged a high level of caution with respect to the prospect of a central-bank-issued digital currency. He noted the potential risk of serious cyber attacks and extensive legal issues that would accompany any foray by the U.S. into central-bank-issued digital currencies. He encouraged continued study in the area, particularly surrounding “secure limited-purpose digital currencies for use as a settlement asset for wholesale payment systems.”

Going forward, Mr. Quarles stressed the importance of enhancing the stability of the existing payment system, and of continuously working to find improvements that are not likely to have detrimental effects on safety and resiliency. He encouraged cooperative efforts to build a safer and more efficient system based on existing institutions.

Lofchie Comment: Vice Chair Quarles raises reasonable concerns about how a virtual currency would perform in a time of stress. One specific worry – that a central bank would adopt digital currency – seems unlikely, given that the central bank would, thereby, lose control over its own currency. A more realistic concern is that fears of an unreliable central bank (think Venezuela) would motivate a population’s movement away from use of that bank’s currency.